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Are Reliance Worldwide Corporation Limited’s Returns On Capital Worth Investigating?

Simply Wall St

Today we'll look at Reliance Worldwide Corporation Limited (ASX:RWC) and reflect on its potential as an investment. Specifically, we'll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

First, we'll go over how we calculate ROCE. Then we'll compare its ROCE to similar companies. Then we'll determine how its current liabilities are affecting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the 'return' (pre-tax profit) a company generates from capital employed in its business. All else being equal, a better business will have a higher ROCE. In brief, it is a useful tool, but it is not without drawbacks. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that 'one dollar invested in the company generates value of more than one dollar'.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

Or for Reliance Worldwide:

0.10 = AU$199m ÷ (AU$2.1b - AU$144m) (Based on the trailing twelve months to June 2019.)

So, Reliance Worldwide has an ROCE of 10%.

Check out our latest analysis for Reliance Worldwide

Does Reliance Worldwide Have A Good ROCE?

ROCE can be useful when making comparisons, such as between similar companies. It appears that Reliance Worldwide's ROCE is fairly close to the Building industry average of 9.9%. Aside from the industry comparison, Reliance Worldwide's ROCE is mediocre in absolute terms, considering the risk of investing in stocks versus the safety of a bank account. Investors may wish to consider higher-performing investments.

In our analysis, Reliance Worldwide's ROCE appears to be 10%, compared to 3 years ago, when its ROCE was 1.9%. This makes us wonder if the company is improving. You can click on the image below to see (in greater detail) how Reliance Worldwide's past growth compares to other companies.

ASX:RWC Past Revenue and Net Income, November 10th 2019

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. What happens in the future is pretty important for investors, so we have prepared a free report on analyst forecasts for Reliance Worldwide.

Do Reliance Worldwide's Current Liabilities Skew Its ROCE?

Liabilities, such as supplier bills and bank overdrafts, are referred to as current liabilities if they need to be paid within 12 months. The ROCE equation subtracts current liabilities from capital employed, so a company with a lot of current liabilities appears to have less capital employed, and a higher ROCE than otherwise. To counteract this, we check if a company has high current liabilities, relative to its total assets.

Reliance Worldwide has total liabilities of AU$144m and total assets of AU$2.1b. Therefore its current liabilities are equivalent to approximately 6.9% of its total assets. With low levels of current liabilities, at least Reliance Worldwide's mediocre ROCE is not unduly boosted.

The Bottom Line On Reliance Worldwide's ROCE

Reliance Worldwide looks like an ok business, but on this analysis it is not at the top of our buy list. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

I will like Reliance Worldwide better if I see some big insider buys. While we wait, check out this free list of growing companies with considerable, recent, insider buying.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.